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MODULE 7

CHAPTER 9
9-2
LLs after tax cost of debt = rd (1-T) = 0.08 x (1 0.35) = 0.052 = 5.2%
9-3
Component cost of preferred stock = rps =

0.09 = 9%

9-5
Cost of common equity = rs =

+g=

0.05 = 0.1333 = 13.33 %

9-6
Stock Beta = 0.8
Yield on a 3 month T-bill is 4%
Yield on a 10 year T-bond = 6% =>Risk-free Rate (Rf) = 6%
Market Risk-premium (RPM) = 5.5%
Rate of Return on a Average Stock in the market last year was = 15%
Calculating Estimated Cost of Common Equity using CAPM:
According to CAPM:
rE = rf + x (RPM)
rE = 6% + 0.8 x (5.5%)
rE = 0.06 + (0.8 x 0.055)
rE = 0.06 + 0.044
rE = 0.104 (or) 10.4%
Estimated Cost of Common Equity (rE) = 8.4%
9-7
WACC = wdrd (1-T) + wpsrps + ws rs

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= 0.3 (0.06)(1-0.4) + 0.05 (0.058) + 0.65 (0.12)

= 0.0917 = 9.17%
9-8
WACC = = wdrd (1-T) + wpsrps + ws rs
0.0996 = 0.09 (0.4)(1-0.4) + rs (0.6)
0.996 = 0.0216 + rs (0.6)
0.078 = rs (0.6)
rs= 0.13 = 13%
Cost of Equity Capital = 13%
9-9
Using financial calculator:
N = 60
PMT = 30
PV = -515.16
FV = 1000
I/Y = 6
Semiannual payment = 12
After tax component cost of debt = rd (1-T) = 12 (1- 0.4) = 7.2%
9-11
a. Historical growth rate in earning:
P5 = P0(1+g)5
6.50 = 4.42(1+g)5
(1+g)5 = 6.50/4.42 = 1.471

MODULE 7

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(1+g)5 = 1.471(1/5) = 1.080

g = 8%
Using financial calculator, input N = 5; PV = -4.42; PMT = 0; FV = 6.50; => I/YR =
8.02% = 8%
b. The next expected dividend per share, D1:
D1 = D0(1+g) = 2.60(1.08) = 2.81
c. Cost of equity:
rs = D1/P0 + g = 2.81/36 + 8% = 15.81
9-15
a.
Required Investments = $30,000,000
Since the total market value of the firm is $60,000,000
Out of that, $30,000,000 is financed through equity, then the weight of equity =
$30,000,000 / $60,000,000 = 0.5
Common equity needed = Total Amount of Investment Weight of Equity
= 0.5($30,000,000) = $15,000,000.
b.
Cost of Equity =

D1
$1.20
g =
0.08 = 0.12 = 12%
P0
$30

After Tax Cost of Debt = Before Tax Cost of Debt (1-Tax Rate) = 8 (1-0.4) = 4.8%
WACC = (Weight of Equity Cost of Equity) + (Weight of Debt After Tax Cost of
Debt) = (0.5 12%) + (0.5 4.8%) = 8.4%

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c. If the capital structure is maintained ie Debt: Equity = 1:1 then WACC will remain the
same. Retained earning is also part of equity. Thus instead of retained earning as in the
previous case here the equity is being increased by the issue of new equity
CHAPTER 10
10-1
NPV = -52,125 +
= -52,125 + 59,611.65 = $7,486.65
10-2
Using Excel with IRR function, we can calculate IRR = 16%
10-3
Using financial calculator, N = 8, I = 12%, PV = 0, PMT = 12000
FV = 147,596
Then we calculate MIRR
N = 8, PV = -52,125, FV = 147,596, PMT = 0 => MIRR = 13.89%
10-4
PI = PV of future cash flow/Initial cost = 59611.95 / 52125 = 1.143
10-5
0

-52125

12000

12000

12000

12000

12000

12000

12000

12000

-52125

-40125

-28125

-16125

-4125

7875

19875

Period payback = 4 +

= 4.343 years

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10-6
0

12000

12000

12000

12000

12000

12000

12000

12000

52125

10714.28 9566.32 8541.36 7626.21

6809.12 6079.57 8428.19

-23303

52125 41410.72 31844.4

Discounted payback period = 6 +

2640.05

15676.83 8867.71 2788.14

= 6.513 years

10-7
a. At 5%:
NPVA = -15000 +

NPVB = -15000 +

= 16,108,952

= 18,300,939

At 10%:
NPVA = 15000 +
NPVB = 15000 +

= $12,836,213
= $15,954,170

At 15%:
NPVA = 15000 +
NPVB = 15000 +
b. Using Excel to calculate IRR:
IRRA = 44%

= $10,059,587
= $13,897,838

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IRRB = 82%
10-8
Using excel to calculate:
IRRT = 15%
IRRP = 20%
NPVT = -17,100 +

= $408.71

NPVP = -22,430 +

= $3,318.10

Using financial calculator, for project Truck: N = 5; I = 14; PV =0; PMT = 5,100; we
have: FV = 33,711.53. Then we enter: N = 5; PV = -17,100; FV = 33,711.53; PMT =
0, we calculate: MIRRT = 14.53%
Do the same with project Pulley, N = 5; I = 14; PV = 0; PMT = 7,500 => FV =
49,575.78. Then we enter: N = 5; PV = -22,430; FV = 49,575.78; PMT = 0, we have
MIRRP = 17.19%
We accept both projects.
10-13
a. Construct NPV profiles for Projects A and B.
r
0%
10
12
18.1
20
24
30
b.
IRRA = 18.1%; IRRB = 24.0%

NPVA
$890
283
200
0
-49
-138
-238

NPVB
$399
179
146
62
41
0
-51

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c. Project A has the higher NPV = $283.34

Project B has NPV = $178.60
For r = 17%:
Prject B NPV = $75.95
Project A NPV = $31.05
Project B would be selected.
d. MIRR for Project A when r = 10%:
PV costs = $300 + $387/(1.10)1 + $193/(1.10)2 + $100/(1.10)3 + $180/(1.10)7 = $978.82
$987.82 = $2,459.60 (1 +MIRR)7
MIRRA = 14.07%
MIRRB = 15.89%
At r = 17%:
MIRRA = 15.57%
MIRRB = 19.91%
e. The crossover rate, and its significance:

Year
0
1
2
3
4
5
6
7

Project a
105
-521
-327
-234
466
466
716
-180

Cross over rate = 14.53%

Both projects are mutually exclusive but only the one with the cost of capital higher than
the crossover rate can be selected.
10-16

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Plane a:
Expected life = 5 years; cost = 100mil.; net cash flow = 30 mil; cost of capital = 12%
Plane b:
Expected life = 10 years; cost 132 mil.; net cash flow = 25 mil.; cost of capital = 12%
NPV = $9.26
Project a is better since it will increase the value of the company by $12.764 mil.
10-21